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GlobalIlluminators FULL PAPER PROCEEDING Multidisciplinary Studies

Full Paper Proceeding TMBER-2014, Vol. 1, 19-25 ISBN: 978-969-9948-36-7

TMBER-14 Takaful (Islamic ): Historical, Shari‟ah And Operational Perspectives

Sheila Nu Nu Htay1, Mustapha Hamat 2 ,Wan Zamri Wan Ismail3 & Syed Ahmed Salman4*

1,2Institute of Islamic Banking and Finance,International Islamic University Malaysia, 3,4Research Student, 2Distinguished Fellow,

Abstract

Insurance is used as one of the risk management tools and it becomes more important in our daily lives due to the complicated business activities. However, the non-Shari‟ah compliant elements such as interest, and uncertainty involved in the insurance make the insurance prohibited from the Islamic perspective. As an alternative, Shari‟ah scholars have introduced takaful (Islamic insurance). The purpose of this paper is to highlight the history, Shari‟ah and operational aspect of takaful. Secondary data is collected from the articles, books and internet resources and then library research is used to get the secondary data. This paper highlights the Shari‟ah background and validity of takaful, its models and management of the takaful risk funds. It is expected that this paper will be the interest of industrial players, consumers, regulators and investors.

© 2014The Authors. Published by Global Illuminators. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/) Peer-review under responsibility of the Scientific & Review committee of TMBER 2014.

Keywords― Takaful, Malaysia, Islamic Insurance, Shari‟ah

Introduction

By nature, human being is weak and there is a tendency that they will try to find a mean to protect and secure them in the misfortune. Common types of risks faced at the individual levels are related to risks to the property owned, for instance, car and house, health, permanent disablement and personal accidents. Risks related to the property involve fire and flood. In the case of health, the cost of medical expenses is a burden for the individuals. Moreover, when someone is suffering from permanent disablement, the continuation and survival of the life is not easy since it needs strong financial support. Similarly, the personal accidents might be difficult to avoid in our daily lives since most of us have experience ranging from the minor to the major accidents. Common current practice to claim the expenses incurred in the case of misfortune is buying the insurance. In most of the cases, parents want the kids to be secured especially in the case of education and they will start engaging in the insurance product, i.e. child education plan. Salary earners are also interested to have sufficient amount of money when they retired and hence, they prefer to buy the insurance products, for instance, investment linked products and retirement products. In addition, the government policy makes the people unavoidable from insurance. For instance, road tax can be renewed if the owner buys the car insurance and it is widely practiced in many developed countries such as Canada, United States of America and United Kingdom and in many developing countries such as Malaysia. In some countries like the United States of America, if the people do not have health insurance, they cannot be admitted to the hospital. Therefore, insurance cannot be avoided due to the living style of our daily life nowadays.

The main purpose of existence of the business entities is to earn profit and it cannot be attained without taking risk. According to the Capital Asset Pricing model, risk and return are highly and positively correlated. This means that the higher the risk is, the more return will be and the lower the risk is, the lesser the return will be. Global Risk Management Survey (2013) mentions the top ten risks faced by the business entities worldwide and they are related to economic slowdown and slow recovery, regulatory or legislative changes, increasing competition, damage to reputation and brand, failure to attract or retain top talent, failure to innovate to meet customer needs, business interruption, commodity price risk, cashflow or liquidity risk and political risk and uncertainties. One of the ways to manage the risk is buying the insurance.

*All correspondence related to this article should be directed to Syed AhmedSalman, Tarbiat Modares University ,Iran

Email: [email protected] © 2014 The Authors. Published by Global Illuminators. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/) Peer-review under responsibility of the Scientific & Review committee of TMBER-2014.

Syed AhmedSalman /TMBER-2014/Full Paper Proceeding Vol No-1,19-25

It could be summed that both individual and business levels need insurance to seek the compensation and coverage in the case of loss and it has been found to be a useful tool. However, from the Islamic perspective, there are prohibited elements in the insurance practice and they are interest, gambling and uncertainty. Thus, Muslim scholars have introduced with Takaful as an alternative to the insurance. However, the concept of Takaful has been practiced before pre-Islamic period. The objective of this paper is to reemphasize on the historical development of Takaful and its Shari‟ah aspect and operational models.

This paper is discussed in parts. The second section presents the historical perspective of Takaful. The third section discusses on the Shari‟ah aspect of Takaful and its models. The last section concludes the paper. Historical Perspective Of Takaful

Some form of insurance and mutual help schemes have been practiced by the tribal Arabs since the pre- Islamic period, some of which were later approved by the Prophet (pbuh). Billah (2000), Khorshid (2004) and Obaidullah (2005) have identified the systems such as al-Diyat(blood money), al-Aqilah, Ma‟qil, al-Qasamah, al- Tahanud, al- Diwan, andDhamanKhatar al Tariq briefly explained below:

The legal ruling on the subject of blood-money was extensively discussed by Imam Malik in his „AlMuwatta‟ under the Chapter, „Kitabal Uqul‟. This system was introduced to replace the primitive custom of „blood called for blood‟ and to curb the fury of war among the various warring tribes. This covers unintentional murder where the entire tribe mutually agrees to provide financial compensation as blood money;

In a similar manner, a system called al-Aqilah (which literally means, ‟Slayer's paternal relative who undertakes to pay blood money") was introduced as a covenant of mutuality formed between the Meccan immigrants (Muhajirrin) and the Medinans (Ansars) whereby members pay their annual contributions through a fund called „al Kanz‟. This fund will be used to pay compensation on behalf of a member who is liable to pay a diyat. This doctrine was approved by the Prophet (pbuh), and later made mandatory by the second caliph, Umar Al Khattab, based on the following :

"…Narrated by Abu Hurairah (ra), he said that: once two women from the tribe of Huzail clashed when one of them hit the other with a stone, which killed her and also the fetus in the victim's womb. The heirs of the victim brought an action to the court of the Holy Prophet (pbuh), who gave a verdict that the compensation for the infanticide is freeing of a male or female slave while the compensation for the killing of the woman is the blood money (diyat) to be paid by the 'Aqilah' (the paternal relatives) of the accused...“ (Al Muwatta‟ Chapter 474).

Besides the system of al-Aqilah, a number of similar systems were practiced during the Islamic civilization such as „Ma‟qil' which was provided under the Constitution of the city-state of whereby each member of a tribe contribute to a fund to be used for payment of ransom money for someone who was made a prisoner of war by an enemy. If the fund is insufficient, other related or neighboring tribes will assist;

Another system is called „al-Qasamah‟, which is a fund jointly contributed by the community to help the family of murdered victims where the murderer could not be found;

„Al-Muwalah‟ is a scheme between two parties with the intention that either one of the two will be responsible in the event where something should occur to his counterpart;

„Al-Tahanud‟, is basically food sharing and rationing scheme for those travelling where all travelling members contribute their food to be pooled together to be shared later;

„Al-Diwan‟, which is a register, the persons whose names contained in the „Diwan‟ owed one another mutual assistance and have to contribute to the payment of compensation. This system was institutionalized during the second Caliph Umar Al Khattab;

Khorshid (2004) who cited IbnuKhaldun in his monumental book the „Muqaddimah‟(Prolegomena), describes that Arab business ventures known as the „Winter and Summer Voyages‟ practiced the concept of insurance where members of such trade voyages participated in a scheme to indemnify any member of the group against loss of their stock or profit, financed through the collection of contributions from members. This is reiterated by Rispler- Chaim, (1985) who cited Fazlur Rahman (1979), that the merchants of used to form a mutual fund called „ DhamanKhatar al Tariq to help the victims or survivors of natural hazards during their commercial ventures and the Prophet (pbuh), who traded with the capital provided by Sayyidah Khadijah (ra), contributed to such fund.

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Among the classical jurist who first recorded the legal basis, meaning and concept of insurance as we know today was a Hanafite jurist, IbnuAbidin who termed insurance premium as „sukra‟ (security)1, followed by the fatwa of Sheikh Abduh legalizing insurance practices (Billah, 2001 citing Klingmuller, 1969).

Buoyed by the fervent Islamic revival (al-sahwah al-islamiyyah) among the Muslim Ummah during the last fifty years or so, where Muslims who seeks to return to their Islamic roots in their lives, the world view of in the economic, political, social and personal spheres begin to germinate interest in the Islamic intelligentsia as narrated by Esposito (1999) as:

“...the indices of Islamic reawakening in personal life are many: increased attention to religious observances ( attendance, prayer, fasting), proliferationof religious programming and publications, more emphasis on Islamic dress andvalues, the revitalization of (mysticism). This broader-based renewal hasalso been accompanied by Islam‟s reassertion in public life: an increase in Islamic oriented governments, organizations, laws, banks, social welfare services,and educational institutions…”

The culmination of these renewed and re-energized efforts to practice Islam in the financial sphere has resulted in the setting-up Islamic banks and followed by takaful companies in various parts of the Islamic world.

As a measure to ensure an orderly development of takaful which is premised on a different legal and philosophical framework and the need to nurture takaful into a strong and well developed business on par with its conventional counterpart, the Malaysian government enacted the first dedicated Takaful Act 1984 in the world to regulate the takaful and retakaful industry. Other countries too have at least amended or endorsed their respective insurance regulations to cater for the unique requirements of the business. BNM have initiated the Financial Sector Master Plan (2000-2010) which targeted the takaful industry and Islamic

IbnuAbidin‟s ruling on insurance is with regards to a merchant who chartered a ship from a shipowner with a mutual understanding that the charterer would pay an additional amount known as sukra (premium) if the ship faces any form of risk, to reasonably indemnify the charterer. banking to contribute at least 20% of the total market share of the financial sector, and followed by Financial Sector Blueprint (2011-2020) which targets Islamic banking and finance in Malaysia to account for at least 40% of the total market share by 2020.

The global takaful industrywith its modest beginnings in the early eighties with less than 10 players worldwide is now churning a multi-billion dollar business spanning across South-East Asia, Middle East, Africa, Central Asia and Europe with more than 200 players. Global takaful contributions according to projections from Ernst & Young (2011) are expected to reach USD 12 billion in 2012 and growing at an average annual rate of 20%-30%. However, this is still a very small fraction of the global insurance contributions which recorded US$4,597 billion in 2011 (Sigma, 2011).

Shari‟ah Background And Models Of Takaful

Whilst fully appreciating the great service and importance of insurance as a risk management tool for individuals, businesses and society, contemporary Islamic scholars are not in agreement with the contractual nature of insurance which are deemed not in line with the precepts of Shari‟ah.They have identified a number of traits of an insurance contract and its practices which are not permissible under Shariah principles and practices namely: elements of gambling (/qimar), elements of uncertainty ( fahish), elements of interest () in addition to elements of fraud and cheating (ghish wa ghabn) andignorance (al-jahala) (Al-Zuhaili, 2002).

This is supported by a number of edicts (fatawas) such as: First Internatioanl Conference on (Makkah) 1976, Resolution of the Fiqhi Academy of OIC 1985, Resolution 12/11 of Al Barakah Group Symposium, Resolution 42 of Al-Rajhi Bank-Saudi Arabia, Resolution of National Fatwa Committee of Malaysia 1972, Resolution of Dewan Syariah Nasional Indonesia 2001 and Resolution of Council of League 1978.From the various fatawas and research from scholars on the subject, the alternative form of „insurance‟ which is permissible under Shariahshould be based on the contract of donation (uqudtabarruat), instead of the conventional commercial contract of exchange (uqudmuawadhah) as it contains major elements of riba, maisir and gharar which invalidates the conventional insurance contract.

Takaful is derived from the root word „kafala‟ which means responsibility, guarantee, amenability or surety. In practice, takaful takes the meaning of joint guarantee, shared responsibility, mutual undertaking among takaful participants against certain financial loss from specific risks where they agree to contribute to a defined fund. It is an

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effort to remove damage or harm when it occurs, through the payment of compensation from the takafulparticipation (as described in the Islamic legal maxim „al dararyuzal‟ (damage or harm is removed) (EngkuRabiah, 2008).

In short, a takaful scheme is an undertaking involving defined participants, making defined contributions, to a defined fund, covering defined risks, in a defined period of time. Takaful as a system, manifest a sense of brotherhood and solidarity among the participants where they agree to help one another as enjoined by (swt) in the Holy :

“and cooperate you one another in righteousness and piety” (Surah al-Maidah Verse 2).

And on the advice of the Prophet (P.B.U.H):

“Narrated by Abu Harairah (r.a) from the Prophet (pbuh), whosoever removes a worldly hardship from a believer, Allah (swt) will remove from him one of the hardships of the hereafter. Whosoever alleviates the needy person, Allah (swt) will alleviate from him in this world and the nex” (Sahih Muslim, Kitab al-Birr, Book 32 No.6250).

In this respect, the Islamic Financial Services Act 2013 (Malaysia) defines Takaful as:

“…“takaful” means an arrangement based on mutual assistance under which takaful participants agree to contribute to a common fund providing for mutual financial benefits payable to the takaful participants or their beneficiaries on the occurrence of pre-agreed events…”

For this purpose, unlike conventional insurance practice, the Takaful Risk Fund (tabarru„fund) is managed and accounted separately from the Shareholders Fund. The takaful operator only acts as the manager and trustee of the Takaful Risk Fund on behalf of the takaful participants.

Contemporary Islamic scholars have recommended that the most suitable contracts to be applied in the management of a takaful business are generally based on three concepts namely, al-mudharabah or al-wakalah or al- or a combination of the three contracts. There are studies by jurists and researchers to employ other contracts such as al-wadiah, etc which has yet to be fully explored. The three models are briefly explained below:

Takaful based on al-Mudharabah Model:

Al-Mudharabah (trustee profit-sharing) may be defined as a contractual agreement between the provider of capital (sahibul mal) and the entrepreneur (mudharib) for the purpose of a business venture whereby both parties agree on a pre-determined profit-sharing ratio, whereas losses of the venture will be the sole responsibility of the capital provider except for losses due to the negligence, misconduct, violation of conditions by the entrepreneur (Usmani, 2007).

The principle of al-mudharabah when applied to atakaful contract defines the takaful operator as the entrepreneur who undertakes the takaful business activities2 and the participants who entrust funds to the takaful operator by means of takaful contributions. The takaful contractmay specify (in some model) the proportion of profit (surplus) to be shared between the participants and the takafuloperator (Aznan Hassan, 2011).

Takaful based on al-Wakalah Model:

The term “wakalah” means performing tasks on behalf of others, delegation of a task or job to another, and in English it generally means agency. The AAOIFI Shariah Standard No. 23 defines wakalah as:

“...the act of one party delegating the other to act on its behalf in what can be the subject matter of delegation...”

Under takaful, this model entails the operator (the wakeel) to manage the Takaful Risk Fund(muwakkalbih) as an agent of the participants (the muwakkil) and is paid a fee (the ujrah) for its services. Profit and losses from the management of the Takaful Risk Fund belong entirely to the participants, unless the losses were due to the negligence or misconduct of the takaful operator3.

Takaful based on al-Waqfmodel

Waqfliterary means, „detention‟ but its legal meaning is, „the dedication of a property or giving it away in charity for a good purpose and other religious, pious or charitable purposes. The establishment of waqf according to Doi (2007) extinguishes the right of the dedicator (waqif)and transfer its ownership to Allah (swt). For takafulunder

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this model, a waqf account has to be established by the operator within the Takaful Risk Fund. To this effect the operator is required to relinquish some kind of “seed” money as waqfto operationalize the said waqf fund. The waqf fund shall work to achieve the following objectives: (i) To extend financial assistance to itsmembers in the event of losses; (ii) To extend benefits to its members strictly in accordance with the waqfDeed.All the expenses related to the underwriting and operational

2Of basically managing the takaful fund collected from participants based on tabarru‟ who agree to jointly guarantee each other against losses defined in the takaful contract.

3The SAC of BNM approved this model at its 24th meeting dated 24 April 2002. cost of takafulshall be charged to the waqf fund. As manager, the takafuloperator will perform all functions necessary for the operations of the waqffund against a wakalah fee to be deducted from the contribution paid by the participants.4

Takaful based on Hybrid Model

This business model is a combination of the two principles of al-mudharabah and al-wakalah. Under this model, a relationship between the operator which combines the role of entrepreneur or mudharibas well as the agent or wakeelof the participant, whilst the latter in the capacity as both provider of capital or sahibul-mal and principal to the agent. By this arrangement on the part of the operator, an agency fee can be remunerated as upfront charges from the Takaful Risk Fund whilst at the same time will have the right to profit-sharing on returns on the investment of the Takaful Risk Fund in accordance with the al-mudharabahcontract.

A summary of the key features of the various takaful modelswas formulated by Ernst & Young (2011) as follows:

Table12.7: Features of Takaful Models Item Mudharabah Wakalah Hybrid WakalahWaqf

Share of None Percentage of Percentage of Percentage of Technical upfront upfront upfront Results. contribution contribution contribution

Share of None None Agreed profit Agreed profit Investment sharing ratio sharing ratio Results.

Share of Pre-agreed None None None Surplus Percentage of (technical and surplus investment results).

Loss on Borne solely by Borne solely by Borne solely by Borne solely by investments. participants participants participants participants.

Operating Borne solely by Borne solely by Borne solely by Borne solely by Expenses. Shareholders‟ Shareholders‟ Shareholders‟ Shareholders‟ Fund except for Fund except for Fund except for Fund except for direct expenses direct expenses direct expenses direct expenses of of the Takaful of the Takaful of the Takaful the Takaful Risk Risk Fund Risk Fund Risk Fund Fund

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Deficit in Qard al Hassan Qard al Hassan Qard al Hassan Qard al Hassan Takaful Risk from from from from Fund. Shareholder‟s Shareholder‟s Shareholder‟s Shareholder‟s Fund Fund Fund Fund

Creation of Participants‟ Participants‟ Participants‟ Participants‟

Takaful Risk takaful takaful takaful takaful Fund. contributions contributions contributions contributions and initial waqf fund from Shareholders‟ fund

Liquidation of Accrue to Accrue to Accrue to Waqf amount Takaful Risk participant‟s only participant‟s only participant‟s must go to Fund. only another existing Waqf fund and cannot be disbursed amongst Participants.

Conclusion

In sum, this paper tries to highlight again the history of Takaful, its Shari‟ah aspect and operational models since Takaful becomes part of our lives nowadays. Literature provides the evidence that the concept of Takaful has been practiced since pre-Islam period and the intention is to help. In addition, the prohibition of insurance due to the involvement of interest, gambling and uncertainty from the Islamic perspective is discussed. This paper further elaborates the dominant Takaful operational models, such as Al-Mudharabah Model, Al-Wakalah Model and Al- Waqf model. It is expected that this paper will be the interest of regulators, industrial players, customers, Shari‟ah scholars and public as well.

References

Al-Zuhaili, Wahbah. (2002). Financial Transactions in Islamic Jurisprudence Vol 1. Damascus: Dar al Fikr. Aznan Hassan. (2011). Fundamentals of Shariah in Islamic Finance. IBFIM. Billah, M.Maasum (2000). Islamic and Modern Insurance Principles and Practices. Ilmiah Publishers. Billah, M.Maasum. (2001). Sources of Law Affecting Takaful (Islamic Insurance),International Journal of Islamic Financial Services Vol. 2. No. 4 Doi, A. Rahman I (2007). Shariah: The Islamic Law. Kuala Lumpur: A.S Noordeen. Engku Rabiah, Hassan Scott, Azman Ismail. (2008). Essential Guide to Takaful (Islamic Insurance), Malaysian Takaful Association, CERT, Kuala Lumpur. Ernst and Young (2011). World Takaful Report. Esposito, L.J. (1999). The Islamic Threat: Myth or Reality? Oxford University Press. Fazlur Rahman, (1979). Banking and Insurance. The Muslims Schools Trust, London Khorshid, Aly. (2004). Islamic Insurance - A Modern Approach to Islamic Banking. Routledge Curzon. Klingmuller, Ernest (1969). „The Concept and Development of Insurance in Islamic Countries‟in , Vol. XLIII, 1969, at 30. Obaidullah, Mohamad. (2005). Islamic Financial Srvices. Jeddah, Saudi Arabia: Islamic Economic Research Centre. Rispler-Chaim, V. (1985).Insurance and Semi-Insurance Transactions in Islamic History untill the 19th Century.

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Journal of the Economic and Social History of the Orient, Vol. XXXIV. Sigma (2011). World Insurance Report, Swiss Re. Usmani, M.Taqi. (2007). An Introduction to Islamic Finance. Karachi: Maktaba Ma'ariful Quran.

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